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At The Food Chains, It's All Gulp And Swallow

May 07, 1995

Finance: DEALS

AT THE FOOD CHAINS, IT'S ALL GULP AND SWALLOW

The hottest action in service industry deal-making these days is down at the supermarket. Such big-time investors as Kohlberg Kravis Roberts & Co., George Soros, and Leon Black have been riding a wild wave of acquisitions in recent months. Some of the buyouts are buildups, where the owners hope to cash in on the classic benefits of market concentration: economies of scale, knocking out smaller, weaker competitors, and carrying more clout with suppliers.

In recent weeks, KKR has agreed to pony up $1.2 billion for Bruno's Inc., a 254-store grocery chain in Birmingham, Ala. A few days later, KKR's Stop & Shop Co. unit said it would merge with Purity in North Billerica, Mass. And earlier this year, Los Angeles' Yucaipa Cos., with strong financial backing from Soros and Black, said it would buy Chicago's Dominick's Finer Foods Inc. for $750 million. Yucaipa is also doing buildups. Over the past eight years, it has acquired numerous small local chains and is consolidating them into a few big ones, mainly units of California's Ralphs Grocery Co., with which Yucaipa has recently merged in a $1.5 billion deal.

Why the sudden flurry of deals? It's mainly caused by market conditions: low multiples, low inflation in food prices, and new technologies. "The time has never been better," says Yucaipa Chairman Ronald W. Burkle. "With technology, there are a lot of things we can do now that would have been impossible a few years ago."

WAFER-THIN MARGINS. Like Wal-Mart Stores Inc. and Toys `R' Us Inc. before, supermarket chains are turning to huge automated satellite distribution centers to drive down costs. At some megamarkets, such as Yucaipa's Food 4 Less chain, distribution centers have been done away with altogether in favor of automated racking systems at the stores. Big chains with strong cash flow are also investing in sophisticated information systems that handle everything from targeting advertising by studying consumer buying patterns to linking up with frequent-flier programs.

Burkle insists that more consolidation is on the way. One reason: Groceries make their money on wafer-thin margins--just 1% to 2%. So because there are economies of scale, larger chains fare better. "There's only room for very large or very small speciality chains," says James S. Schmitt, an analyst at Westcountry Financial. "Middle-sized companies are getting squeezed out."

As the big players keep rounding up more and more chains and keep streamlining, they can feel confident that their cash flow will steadily increase. "People have to eat," says KKR general partner Paul E. Raether. But for quite some time to come, the biggest bites will be taken by the dealmakers.By Eric Schine in Los Angeles, with Leah Nathans Spiro in New York